4/14/2009 @ 6:00PM

Transcript: Thomas Cooley (Part One)

Forbes: So, restoring financial stability. How do you write a book that pretty much makes a prescription and also describes what happened, while it’s happening?

Thomas Cooley: It’s not an easy thing to do. But I have to say it was one of the most rewarding experiences of my life as an academic. Because what we did is sort of issue a challenge to our faculty who were out there making pronouncements about what has happened and dissecting what had gone wrong. But the challenge was what do we have to say about how to fix it. And if we don’t have something to say about that what are we doing in this business. And, you know, things tend to proceed at a fairly leisurely pace in academia. But our goal was to try to get some ideas in front of policy makers–in front of the people who are going to be making the policies and leading the discussions. So that’s why we did it so quickly.

Yes, how long did it take you to put together?

We had our first meeting on Nov. 1. And we shipped drafts of the book to all the major policymakers and people on Obama’s team, Senate Finance Committee and heads of central banks around the world and around the country before Christmas. And it was in print by March 6, which is a record.

Did it have feedback from the people who you had sent it to as well? Was there some back and forth?

We did have some feedback. I got feedback from a number of Fed presidents and from people on various committees of the House and the Senate.

So, you’re also then a pioneer of a kind of instant peer review?

I guess, yes. Yes. And we knew that events were going to evolve very quickly and that probably some of the things that we had to say would be obsolete by the time we had books in hand. But, nevertheless, it seemed to be important to get some ideas on the table. And we managed to pull together a group of 33 or so faculty members who all contributed to it.

It added up to some conclusions from some really diverse viewpoints. One thing that comes through is the importance of the Fed’s actions and the Treasury’s actions, but also your caution about the socialization of risk.

Yes, yes. I think one of the key ideas in this book is that if the government approaches financial crises and financial regulation by giving a lot of under-priced insurance, then that’s socializing risk in the economy. And that’s a very bad thing to do because that encourages the creation of more systemic risk.

Was the haste in which the Treasury felt it had to act at first a problem in terms of that? It seems like they didn’t consider.

I think the both the Treasury and the Fed, they decided at some point that moral hazard was not something they could stop to worry about. And that they had to calm the system, fix things. And so, bailouts, guarantees, those sorts of things are attempts to calm the system without taking account necessarily of what the longer-term consequences are going to be. And it’s a very delicate balance. Because if you’re in the middle of a crisis, the very first thing you want to do is calm things down. You know, as in the 1930s, you want to stop the runs on banks. But it’s very important how you do that. And if you do it in a way that creates more systemic risk, then you’re just sowing the seeds of the next crisis and the next problem.

We were talking earlier about the kind of heated rhetoric that’s resulted from all of this. Is that tied to some of these initial actions? How things were perhaps structured?

Well, possibly. Yes, I think so. I mean, certainly areas like executive compensation. The very fact that so much money has been poured into the financial sector to try to fix it has sort of elevated the rhetoric. But then, attempts to deal with the economic crisis have also elevated the rhetoric, and I think that’s part of it. I think, you know, taxpayers should be legitimately concerned that risk is being socialized, and, you know, profits are still privatized.

Now, Geithner has a new plan to recapitalize the banks by partnering with private entities and buying mortgage securities. Do you think the public stands to make money on this, the way the deal is structured?

I think the private sector stands to make money on it. I think it offers private investors a very good deal. How badly the private sector will be burned by this, I don’t know. I think actually, if it works, then it shouldn’t cost the public, the taxpayers, very much. If it works, however, there could be a lot of private investors who make a lot of money. And, you know, people may have concerns about that when they realize that that’s what’s happened.

The Treasury secretary has said, “We’re standing shoulder to shoulder with these private interests.” That’s not quite true, right?

Yes. I think they’re standing a few yards in front of the private interests in terms of being exposed to risk. And it’s not true.